1. Planning and control. A good budgeting
system must provide for both planning and control.
Planning involves developing objectives and preparing
various budgets to achieve those objectives. Control
involves the steps taken by management to ensure that the
objectives set down at the planning stage are attained
and that all parts of the organization work together
towards those objectives.
2.Advantages of budgeting. There are many
advantages to budgeting, including:
- Budgeting provides managers with a vehicle for
communicating their plans in an orderly way throughout
the entire organization.
- Budgeting requires managers to give planning top
priority.
- Budgeting provides a means of allocating resources
to those parts of the organization where they can be
most effectively used.
- Budgeting uncovers potential bottlenecks before
they occur.
- Budgeting coordinates the activities of the entire
organization by integrating the plans and objectives
of the various parts.
- Budgets provide benchmarks for evaluating
subsequent performance.
3. Responsibility accounting. A manager should
be held responsible for those items of revenues and
costs-and only those items-that the manager can actually
control to a significant extent. The manager who is held
responsible for a specific cost should have a budget
specifying a limit on how much can be spent. This limit
may be adjusted, depending upon the activity during the
period. This idea will be developed in later
chapters.
4. Choosing a budget period. Budget periods
vary in length. Some may be as short as a month, whereas
others may cover many years. The most common budgeting
period, however, is a year.
- Operating budgets ordinarily cover a one-year
period. Additionally, many companies divide their
operating budgets into quarterly or monthly
periods.
- A continuous or perpetual budget is one that
covers a 12-month period but which adds a new month on
the end as the current month is completed. This
approach stabilizes the planning horizon at one
year.
5. Self-imposed participative budget. The
most successful budget programs involve lower-level
managers in preparing their own budgets. There are two
basic reasons: 1) lower-level managers are more familiar
with the details of their own operations than top
managers and 2) managers tend to be more committed to
budgets that they have been able to influence.
6. Human relations. Management must keep
clearly in mind that budgeting involves coordinating and
motivating people and the human dimension is of primary
importance.
- Top managers must clearly convey the message in
actions as well as in words that budgeting is
important. If top management appears to be ambivalent
about the benefits of budgeting, others in the
organization will be reluctant to commit their own
time and energy to the budgeting process.
- If there is a preoccupation with getting every
dollar and cent right or with placing blame, the
budgeting process will be resented and managers will
attempt to "game the system." Budgets should not be
used as a club. They should be a way of ensuring that
everyone understands what is expected. Significant
deviations from the budget should be investigated so
that managers understand changing conditions and their
implications for the organization. Managers should not
ordinarily be punished for deviations from the
budget.
NOTE: Budgets in
large organizations can be very complex. The budgets in the text are substantially simplified. Even so,
these simplified budgets are quite intricate and the
level of detail may appear overwhelming. Each step in the process is fairly simple,
but the budgets must fit together. Return to Exhibit
9-2 from time to time to provide the context for each of
the separate budgets making up the master budget.
1. The Sales Budget (Schedule 1 in the text).
The sales budget is a detailed schedule showing the
expected sales for the coming period. It is typically
expressed in both dollars and units of the product. The
sales budget is usually accompanied by a schedule of
expected cash receipts. The schedule of expected cash
collections should take into account delays in collecting
credit sales.
2. The Production Budget (Schedule 2 in the
text). The budgeted production for each period can be
determined by adding together the budgeted sales and the
desired ending inventory and then subtracting the
beginning inventory. The desired ending inventory in
units for each period is usually a predetermined
percentage of budgeted unit sales for the following
period. The production budget is typically expressed in
terms of physical units rather than in dollars.
In a merchandising firm, a merchandise purchases
budget would replace the production budget. The
merchandise purchases budget shows the amount of goods to
be purchased from suppliers each period. This can be
determined by adding together the budgeted sales and the
desired ending inventory and then subtracting the
beginning inventory. As in a manufacturing firm, the
desired ending inventory in units is usually some
predetermined percentage of the unit sales for the
following period.
3. The Direct Materials Budget (Schedule
3 in the text). Once production needs have been
determined, a direct materials budget should be prepared.
This budget details the materials that will be required
to fulfill the production budget and to ensure adequate
inventory levels. Sufficient amounts of raw material must
be acquired to meet both production needs and to provide
for desired ending inventories. Materials purchases can
be determined by adding together the materials required
for production needs and the desired ending materials
inventories and then subtracting the beginning inventory.
The desired ending inventory in units is usually a
predetermined percentage of the number of units that are
expected to be used in production the following period.
The direct materials budget is usually accompanied by a
schedule of expected cash disbursements for raw
materials. This schedule should take into account any
delays that are anticipated in paying for materials.
4. The Direct Labor Budget (Schedule 4 in
the text). Once production needs are known, the direct
labor budget must be prepared so that the company will
know whether sufficient labor time is available to meet
those needs. The direct labor budget is typically
expressed in both direct labor-hours and in dollars.
Translating the direct-labor requirements into spending
can lead to complications if there is overtime or if
there is some sort of guaranteed employment policy.
5. The Manufacturing Overhead Budget (Schedule
5 in the text). The manufacturing overhead budget lists
all production costs other than direct materials and
direct labor. Manufacturing overhead costs should be
broken down by cost behavior for budgeting purposes.
Typically, the variable portion of manufacturing overhead
is assumed to be proportional to budgeted activity and
the fixed portion is assumed to be constant in total.
Under the assumption that depreciation is the only
significant non-cash manufacturing overhead expense, the
manufacturing overhead expense can be converted to a cash
flow basis by backing out of the total any depreciation
charges.
6. Ending Finished Goods Inventory Budget
(Schedule 6 in the text). This budget details the amount
and value of ending inventory on the budgeted balance
sheet. The unit product cost from this budget is also
used to compute the cost of goods sold for the budgeted
income statement. The details of the computations will
depend upon whether variable or absorption costing is
used. Managers often want budgets on an absorption
costing basis since that is the basis that will
ordinarily be used to report results to outsiders. Data
for the computations in this schedule are found in the
direct materials, direct labor, and manufacturing
overhead budgets.
7. The Selling and Administrative Expense
Budget (Schedule 7 in the text). The selling and
administrative budget lists the anticipated
non-manufacturing expenses for the budget period. In
practice this budget is usually made up of many smaller
individual budgets negotiated with various managers
having sales and administrative responsibilities. Setting
appropriate budget limits for selling and administrative
functions is one of the most difficult problems in
management accounting and is just beginning to be
understood.
8. The Cash Budget (Schedule 8 in the
text). The cash budget should be broken down into time
periods that are as short as feasible in order to alert
management to problems that may occur due to fluctuations
in cash flows. As anyone with a checking account knows,
it is quite possible to have a positive overall cash flow
during a period and yet be overdrawn at some point during
the period. The cash budget is composed of four major
sections:
a. The receipts section.
b. The disbursements section.
c. Cash receipts, plus the beginning cash balance,
less cash disbursements results in cash excess or
deficiency. If a deficiency exists, additional funds
must be arranged for. If an excess exists, previous
borrowing can be repaid or short-term investments
made.
d. The financing section of the cash budget
provides a detailed account of the borrowing and
repayments projected to take place during the budget
period. It also includes a detailing of interest
payments.
NOTE: For simplicity, all of
the interest calculations in the text, transparencies,
and problems assume simple interest is used with no
compounding.
9. Budgeted Financial Statements
(Schedule 9 in the text). The last components of the
master budget consist of the budgeted income statement
and the budgeted statement of financial position. The
balance sheet is perhaps the most difficult of the
statements to construct in the examples we use. It
requires pulling together data from a variety of
schedules and sources.
NOTE: After reviewing the
makeup of each budget within the master budget, return to
Exhibit 9-2 and think of how the order in which the
various budgets are prepared could be altered. This
process helps to clarify in your mind the
interrelationships of these various budgets.
